Don't forget why you built up an emergency fund in the first place.
Headlines proclaiming massive jumps in cryptocurrency prices might make you eager to invest. You're not alone: An estimated 14% of Americans own some crypto, and many bought it for the first time during the pandemic.
But what if you don't have any cash to spare? Should you use your emergency fund and then replenish it further down the line? Here are some reasons why that could be a risky plan.
1. Emergency funds are for emergencies
If you've saved an emergency fund, congratulations. It isn't easy to do. And if you haven't yet saved enough money to cover three to six months' worth of living expenses, it may be a good time to try building one. You don't have to fill it up overnight -- even if you put a small amount of cash aside each month, you'll slowly build a cushion against financial disasters.
In times of crisis, money is the last thing you want to be worried about. If your car breaks down, your family pet gets ill, or you lose your job, an emergency fund gives you a better chance to cover those costs without having to go into debt.
So, where should you keep your emergency stash? It needs to be somewhere safe and easy to access. That's why investing it in cryptocurrencies may not work well -- cryptocurrency investments can be risky, and you might not be able to get your money when you need it.
In contrast, your funds will be safe in a high-interest savings account. You have easy access to your money, and most accounts have FDIC insurance. That means you're covered for up to $250,000 in case of bank failure or theft.
2. It makes sense to invest for the long term
When you make the decision to invest your cash rather than keep it in a savings account, you open the way to higher returns. But you also take on more risk. Cryptocurrency and stock investments can go down as well as up. And risky investments like cryptocurrencies can increase and decrease dramatically.
That doesn't mean you shouldn't invest. Over time, investments are likely to give you higher returns than money you leave in the bank. But you shouldn't invest money you may need in the short term.
Let's say you decided to buy Bitcoin back in 2017 when you saw how much money other people were making. If you bought $1,000 worth of Bitcoin mid-December, you would have unknowingly bought at a peak. In just a few months, the $1,000 worth of Bitcoin you bought would have seen its value almost halved to about $560.
None of us have a crystal ball, so we don't know where the peaks will be. But if you're investing money you know you won't need any time soon, you can weather the storm and wait for the value to rise again. Indeed, if you'd held on to that same Bitcoin, it would be worth over $3,000 today.
The Ascent's parent company, The Motley Fool, owns Bitcoin for this reason. It sees long-term value in the world's top digital currency and is comfortable waiting out any dips.
3. You could lose it all
You've worked hard to save up an emergency fund. It is there to cushion you against unexpected expenses. If you use it to buy something that happens to lose half its value in two months, and then you face a financial emergency, you could get stuck unable to pay. You might then have to borrow to cover that expense -- or sell your crypto at a loss.
Crypto's volatility is not the only risk you face. Cryptocurrency is a new and relatively unregulated world, which means you don't have the same protections you'd have with a regular bank. No matter how careful you are, you could still lose all of your crypto if:
- Your crypto wallet is hacked
- The exchange you're using collapses
- The coin you buy turns out to be a scam
You might wonder whether to go for stablecoins instead. These are coins tied to a fiat (traditional) currency like the U.S. dollar and are less volatile. Some exchanges pay an annual percentage yield (APY) of over 10% on stablecoins, which may be tempting.
They are certainly safer. But you still might not want to risk your emergency cash. That money is still unlikely to be FDIC insured. And right now, because the type of account is so new, those high interest rates come with hidden risks.
No matter how tempting it is to put all the money you can lay your hands on into crypto, don't gamble with your emergency fund. Instead, if you want to build your crypto investments, look at your budget and figure out how much you could spare each month. Then use a reputable cryptocurrency exchange and slowly build your crypto portfolio. As long as you don't invest more than you can afford to lose, you'll be well placed to ride the crypto rollercoaster.
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We're firm believers in the Golden Rule, which is why editorial opinions are ours alone and have not been previously reviewed, approved, or endorsed by included advertisers. The Ascent does not cover all offers on the market. Editorial content from The Ascent is separate from The Motley Fool editorial content and is created by a different analyst team.
Emma Newbery owns Bitcoin. The Motley Fool owns shares of and recommends Bitcoin.
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